Category: Litigation

When in Doubt, Cross-Appeal!

The Law Court recently addressed an issue of great importance to appellate practitioners: does a party need to cross-appeal a favorable judgment in order to preserve an argument providing alternate grounds for affirmance, when the lower court rejected that argument? The answer, per the Law Court’s decision, is “yes.” As the Law Court’s decision makes clear, and as my predecessor on this blog has noted, a cross-appeal is the only way to ensure that you will be able to raise the argument on appeal.

The decision, Reed v. Secretary of State, which is also very interesting substantively, involved a challenge to the Secretary of State’s determination that proponents of a citizen initiative had gathered enough signatures to place the initiative on the ballot. The petitioner’s challenge required the Superior Court to interpret statutes, 21-A M.R.S. § 903-E and 4 M.R.S. § 954-A, regulating the activities of notaries. Intervenors in the action argued in the Superior Court that the statutes were unconstitutional. The Superior Court declined to reach that argument, instead ruling in favor of the intervenors on other grounds.

Intervenors did not cross-appeal after the petitioner filed a notice of appeal. Instead, in the Law Court, intervenors argued that the statute was unconstitutional as an alternate grounds for affirmance.

The Law Court did not address intervenors’ argument. Instead, it wrote in a footnote:

We have no reason to address the constitutionality of [Section 903-E or Section 954-A] because . . . none of the parties who appealed from the Secretary of State’s decision ended up arguing that either provision is unconstitutional.

(emphasis added).

The take-away? If the trial court rules against you on any argument you make, cross-appeal if you want to raise that argument before the Law Court!

This is to some degree a peculiarity of Maine courts. Generally, you can raise any argument you want on appeal to sustain a judgment in your favor. The key to determining whether to cross-appeal is usually whether you want a part of the judgment changed. But the Law Court takes a different view. There is some question about whether this is the right rule – after all, usually there is no standing to appeal unless you have been adversely impacted by the judgment. But it is the rule.

©2020 Pierce Atwood LLP. All rights reserved.

For more on legal appeals, see the National Law Review Civil Procedure section.

IMS Insights Podcast: Episode 16-How Attorneys Can Leverage Trial Presentation Consultants to Advance Cases Amid COVID-19

In this episode of the IMS Insights Podcast, we speak with trial presentation advisor Jeff Dahm about utilizing trial presentation consultants amid the COVID-19 pandemic.

 Teresa Barber: Jeff, I want to welcome you. Thank you for being our guest today on the IMS Insights Podcast.

Jeff Dahm: Great. Thanks for having me.

Barber: Tell us a little bit about your background. How did you first become interested in trial presentation?

Dahm: Well, I graduated from college in 1996 and I got a job. I went to the career center. There was no internet in ’96, so I got a job. I went to the career center, found a job at a jury consulting firm as a research analyst and I didn’t know really much about the law and I definitely hadn’t been in a courtroom at that point in my life but I went right in and I worked for a pretty prominent jury consultant setting up jury research projects around the country and it was really fascinating. It was new for me. I didn’t know anything about this and I knew it was for me. I mean I was always a very technical person. I was always setting up computers and helping people with their stuff and their computers and on the emerging edge of computers always but I didn’t really work in computers then.

Dahm: So, when I was working at this jury consulting firm, there was a woman who had her boyfriend was starting up a company that did trial presentation. Well, I didn’t know what trial presentation was, so she’s like, “I know you’d be great with him. Why don’t you go meet him?” So, I went to his office and met him and they hired me and then I started being … Working in trial presentation. So, it was … I made the shift from jury consulting. I mean I knew I liked trial consulting for sure. I knew it was a job for me, I just didn’t think that the jury consulting job was the right fit at that point in my career. So, I used all my technical skills and got this job and so what we did was we started doing trial presentation around the country and it was pretty new in the early 90s.

Dahm: In the mid-90s, it was really new. I mean there wasn’t a lot of trial presentation. It’s like I always had this desire to perform and to be on stage but I have no talent. I can’t sing and I can’t dance but I knew this was my performance. This was my way to be performing because I was really technical and I was really good at being technical and being good under pressure. So, when I started doing this, this satisfied my performance itch that I’ve always had and I loved it and it was just great and I knew that this was going to be my career.

Barber: I was going to say, it sounds like you walked right into the fire and at a really early stage and-

Dahm: I did.

Barber: That role, so there really wasn’t a whole lot of … In terms of best practices and models, you’ve really had to be there at the forefront for a lot of that.

Dahm: Yeah, it was really exciting. It was just … I graduated with a degree in environmental analysis and design and thought I was going to save the world and all of a sudden, I’m in this new career and I was like wow, this is exciting. Traveling the country, setting up courtrooms, working with attorneys. I mean I was 23 years old and this was truly exciting for me. I mean it was just … I was over the moon about this job, this new job I had.

Barber: So, kind of the nexus too of technology, which is a passion, right? And then like you said that so much on the line for presentation in the middle of a trial. What exactly … And I’m sure that it’s evolved too, right? Since the mid-90s, late 90s to today, what are the fundamentals? What does a trial … A hot seat consultant, a trial technician do?

Dahm: Sure. Well, as a basis that hasn’t changed in the 25 years I’ve been in the business, what hasn’t changed is that you’re putting on a show and you’re responsible for everything that the jury and the judge see and it’s a big, big responsibility but that’s your job and so your job is to organize the evidence in your trial presentation software and help the attorney put together the show that you’re going to put on in the courtroom. So, you’ve got to do run throughs, you practice the night before. You make sure you have all of your highlights ready. You make sure you have your deposition clips. It’s putting together any sort of evidence that you would ever need to show a jury and organizing it and being able to call it up really fast in the courtroom and that really hasn’t changed much over the 25 years. That’s the job.

Dahm: I mean sometimes you do less, clients want to do more. Sometimes you do a lot more. Sometimes you’re full throttle. Sometimes you just set it up for them and they go on their own, but it just depends. It’s just all-encompassing in trial for the evidence.

Barber: Very interesting. It sounds like there’s a lot that leads up to it, right? It’s not just showing up and-

Dahm: No.

Barber: You’re putting a presentation forward, how important is a focused strategy for trial presentation? Does that matter?

Dahm: Yeah. Oh sure. I mean every trial presentation consultant has their own sort of method of operation that they do. For me, it’s getting in with the client very early, making sure that they know that I’m here to help them and I’m going to take care of everything, being very organized with anything they give you that they request that you want, you reply back fast. You have to reply fast. You have to get the work done quick and you have to be very efficient and also, you have to be able to speak to attorneys very well. So, that’s the key is you have to be able to roll right into their world and be able to talk and work just as though you were one of them.

Dahm: So, you’re going to different attorneys all around and everybody has different work styles and so the key of a great trial presentation consultant is to be able to meld into the trial team that you’re working with and that is the most important thing. I now schedule a lot of trial techs for courtroom trials and what’s really important in a strategy is a culture fit, to make sure that this tech fits in with you, that you kind of click because I find that the clients that I do the best job for, I click with them. There’s just like a bond, kind of like something you can’t explain like when you meet someone, you click, if you click, then you’re great but I can also make myself click if I have to and that’s the differentiation in a great trial presentation consultant is you blend in, you make yourself blend in in order to let them trust you so that you can be effective in court.

Barber: I was going to say because there’s a lot of trust that gets put in you or in a trial consultant technician because there’s … Really, that attorney has to be able to say, okay, I know that this needs to appear at this point and you’ve got to be able to pick up those cues, so that’s really interesting to have.

Dahm: You have to be able to click, yeah there has to be trust, you’re right. You’re so right that trust is key. Your whole case, their whole case kind of depends on you, what comes up on the screen. So, when you meet these clients the first time, you have to come in there showing them that you can command the room, you can command a presentation and you can get the job done and those are the really key things that I look for in consultants too when we’re placing them with attorneys is they have to be forward. They have to be forward thinkers. They have to be proactive people because those are the ones that do the best in court.

Barber: Yeah. And I want to ask you too, because we’re here, Jeff, in the middle of summer 2020 and we are in a … Really, in a lot of ways, what’s an unprecedented time, a lot of concern everywhere for colleagues, for communities dealing with COVID-19. It’s also the pandemic, we have a global pandemic, placed an unprecedented amount of stress on the court system and we’ve even seen remote trials popping up. First, it was remote hearings, lately remote trials in some places like throughout California. Can you talk to me a little bit about what you’ve been seeing from clients, what you’ve been hearing from the ground and how important it might be for a dedicated trial presentation consultant or someone with that expertise when you’re thinking about what that completely visual and virtual setting … Can you talk to me about what you’re hearing?

Dahm: Yeah, so as I’m sure everybody has realized in the past few months being at home is that most people are not fully comfortable with the scenario of talking to people over a video conference. It’s not natural. It could be exhausting. There’s a lot of other layers that people don’t realize that come with that. As a consultant working around the country, I have been and trial presentation consultants have been working in video conferences, working at this method for years now and this is a very comfortable place for us to be. This is … And also, when you are presenting, because … Okay, so courtrooms that … Most courtrooms are now pushing towards having Zoom hearings, having Skype hearings. This is a really, really common thing that’s happening more and more and I tell you, if a courtroom is not doing it now, they’re going to be doing it soon.

Dahm: This is the way of the immediate future for the next few years and you need to be prepared and when you’re giving an argument, just like in court, there’s a lot of things to think about beyond your argument and you should let a consultant handle that for you. Let your trial presentation consultant run your PowerPoint. You have to let them help and we can display in a video conference the same as we can in court. You can put things up. You can share the screen and this is something that trial techs and trial presentation consultations are good at, manipulating multiple different views for things to go on the screen, coordinating with people and tech. I mean this is our wheelhouse. So, you are doing yourself a huge favor by having the trial presentation consultant on a call for you in a hearing. I mean it’s invaluable as far as I can see.

Barber: Yeah, I was going to ask you, so it sounds like some of the same principles that you apply in trial presentation in a physical courtroom, how, can you talk to us about how you apply those fundamentals and those principles to help clients prepare and move cases along right now?

Dahm: Sure. Well, and I’ve heard this from my clients too, the cases are not going away. Even though, the public … The in-person hearings are not happening, the cases aren’t going away. They’re still moving forward. You’re still going to have to go forward with your discovery. You have to … Your expert witness disclosures, I mean everything is still happening. So, it’s important that you use your trial consultants as you always would to help move your case forward. Send them your video if you have video depositions that need to be prepared. It still has to happen. Let’s say you have to submit your video deposition designations for your trial that’s in July, that still has to happen. These consultants, and we’re ready to go, we are ready to help you just like we always are when you got to be in court. We are just as ready to help you with your online hearing. I mean it’s just as important, so you should treat it that way.

Barber: And we’re seeing … We’re kind of touching on this, you mentioned like just a lot of hearings moving to Zoom or Skype and if we’re not seeing that now, brace for it because it’s coming. So, what tools and resources would you recommend right now for litigators or attorneys just preparing for a virtual in-court scenario, maybe don’t have one scheduled yet but want to be prepared?

Dahm: So, we are all doing our homework here on the presentation side. I know all the trial techs that we work with and also everybody at my firm, other consultants in general, we’re all doing our homework and we’re all making sure that you all can … That the attorneys can do all of their hearings online. I know that we’ve done a lot of Zoom hearings so far. I know that some consultants are creating a virtual courtroom scenario in order to have everybody log in. I mean there’s just … There’s really a lot of work been going on, on the consultant side to make it easier for clients when they do have the hearings. So, reach out to your consultants because they want to help you and they also know what’s happening. They know. They have their pulse on the industry, especially this ever-changing industry as we speak. So, they want to help you and they’re very, very eager to help. Trust me, I’m one of them.

Barber: Jeff, could you … Are you seeing anything about how you think that the pandemic is potentially affecting software that’s used in the firm and the platforms in the industry?

Dahm: Definitely, sure. So, trial presentation software has evolved over the years, but I feel like this is going to cause it to evolve even more. I mean I’ve been testing a lot of software, all of our software that we do use in court to see that it works on a Zoom hearing and it does but I feel like now, the trial presentation software, they’re going to start to create another layer in their software for online hearings because to make sure it’s not buggy because you are still doing a presentation over the internet through another platform and I would think that these trial presentation software companies are going to align with Zoom and create a software to present with Zoom. I mean these are things that I can see coming down the pipe that will be really exciting. I feel like this, as we know, necessity is the mother of invention and this is going to force companies that make trial presentation software to incorporate the video conferencing aspect to it to make it a little easier for us trial presentation consultants.

Dahm: I mean we can do it now. I can display a PowerPoint. I can click through. I mean I’m quite fluid with it on a video call because I do it all the time. I can click through OnCue. I’ve had a couple of Markman so far online that I was able to click through my documents, go back in my PowerPoint. It’s very fluid. However, I see there’s a couple of points that could be better and I know in the next six months, you’re going to start seeing PowerPoint coming out with online things in integrating into their online applications, same with OnCue, Trial Director, pretty much all these things that we use in court, they’re going to have to start talking to Zoom because I know they’re going to want to make it easier for everybody, which is great. So, it’s just really great but us consultants are on that pulse, so if anybody gives me a call, I can tell you what’s going on.

Barber: Hold on, I want to ask you, you raised that suggestion, thinking about the other hot seat operators, the industry, a lot of independent contractors that maybe don’t work with a firm like IMS or The Focal Point, what advice do you have for other folks in the industry right now with so many courts closed?

Dahm: Yeah, so you have to pivot your skills. I mean as a trial presentation consultant, you understand that you have certain skills. You can work under pressure. You can work technically under pressure. You can display evidence fast. I mean these are all things that are going to be needed to do in a video conference hearing too. Assisting in these online hearings is going to be crucial. I mean I think that since this is the beginning of this online hearing generation, clients are going to be slow to react at first, just like in general with the trial presentation consultant.

Dahm: You’re slow to bring people on and then once you have your first hearing and you realize that your PowerPoint is not displayed effectively, then you’re going to give us a call. So, also, a lot of independent trial presentation consultants can record online depositions. That’s a thing that I’ve seen a lot of trial techs that are getting into right now is to assist clients in online depositions. So that’s been a big thing for a couple of my consultants I work with too.

© Copyright 2002-2020 IMS ExpertServices, All Rights Reserved.

Court Rejected A Trustee’s Objection To Personal Jurisdiction In His Individual Capacity But Affirmed The Objection In His Capacity As Trustee

In Hanschen v. Hanschen, a trustee challenged a default judgment. No. 05-19-01134-CV, 2020 Tex. App. LEXIS 4075 (Tex. App.—Dallas May 28, 2020, no pet. history). The family sued the trustee in his personal capacity and in his capacity as trustee for breaching fiduciary duties. While the trustee was in Texas, the family served him in his personal capacity. The family then obtained a default judgment against him in both capacities when he did not file an answer. Later, the trustee filed a special appearance challenging the court’s personal jurisdiction, and the trial granted the motion. The family then appealed.

The court of appeals reversed the special appearance against the trustee in his personal capacity. The court held that because the trustee was personally served in Texas, the trial court had personal jurisdiction over him:

In this case, the family personally served James with the petition and citation while he was in Texas. The family concedes they “have never asserted that Texas has general jurisdiction over James or that the traditional minimum contacts analysis would be met in the absence of his physical presence.” They are correct and the case law is clear that a trial court has authority to exercise in personam jurisdiction over a nonresident where the court’s jurisdiction grew out of the personal service of citation upon the nonresident within the state. A nonresident, merely by reason of his nonresidence, is not exempt from a court’s jurisdiction if he voluntarily comes to the state and thus is within the territorial limits of such jurisdiction and can be duly served with process.

Id. The trustee also argued that the court did not have adequate jurisdiction over him in his personal capacity because there were no claims against him in that capacity, but the court of appeals disagreed:

While we may agree with James that the default judgment granted relief against the entities for which it would be necessary for Texas courts to have jurisdiction over James in representative capacities, the family’s petition pleaded causes of action against James individually for breaches of fiduciary duties arising from his role as trustee of the Progeny Trust and his roles in NBR-C2, NBR-C3, and NBR-Needham. The family seeks exemplary damages against James for these alleged breaches of fiduciary duties. James does not make a specific argument why these claims are not pleaded against him personally. In Texas, generally an agent is personally liable for his own tortious conduct. For these reasons, we agree with the family that James was personally served with process in Texas, so the trial court has personal jurisdiction over him in that capacity.

Id.

The court of appeals then turned to whether the trial court had personal jurisdiction over the trustee in his capacity as trustee. The court noted that the citation was not issued to him in that capacity. The court held that this defect was dispositive and affirmed the special appearance for the trustee in his representative capacity:

We have held, “[t]he capacity in which a non-resident has contact with a forum state must be considered in the jurisdictional analysis.” James was not served with a citation directed to him in any representative capacity; only “JAMES HANSCHEN WHEREEVER HE MAY BE FOUND.” At oral argument, the family argued the listing of all the parties in the citation was sufficient to constitute service on James in each representative capacity he was listed as a defendant. We reject this contention and the family’s counsel acknowledged in oral argument a citation addressed to one defendant inadvertently served on a different, unrelated defendant would not constitute good service of process merely because all defendants’ names were in the list of defendants in the style of the lawsuit… In this case, James was not served with citations which were returned to the court clerk stating he had been served in his representative capacities. Any failure to comply with the rules regarding service of process renders the attempted service of process invalid, and the trial court acquires no personal jurisdiction over the defendant. A default judgment based on improper service is void. Accordingly, the trial court did not have personal jurisdiction over James in his representative capacities.

Id.

© 2020 Winstead PC.

BREAKING: US Supreme Court Rules Title VII Protects LGBTQ Employees

In a highly anticipated decision, the U.S. Supreme Court held Title VII of the federal Civil Rights Act protects LGBTQ employees from being fired because of their sexual orientation or gender identity.

The opinion, released on June 15, 2020, was a consolidation of three federal appellate court decisions—Bostock v. Clayton County; Altitude Express v. Zarda; and R.G. & G.R. Harris Funeral Homes v. Equal Employment Opportunity Commission. In each case, the employer terminated the plaintiff after learning that he or she was gay or transgender.

In Bostock, the 11th Circuit Court of Appeals held Title VII did not protect an employee against discrimination because of his or her sexual orientation, relying on circuit precedent. The 2nd Circuit came to the opposite conclusion in Zarda, concluding an employer discriminated on the basis of sex (including gender stereotypes) when it terminated a long-time employee. In R.G. & G.R., the 6th Circuit held Title VII protected against discrimination based on an employee’s transgender or transitioning status because such discrimination is grounded in an employee’s failure to conform to gender stereotypes.

Justice Neil Gorsuch, writing for the majority, analyzed whether discrimination because of sexual orientation or transgender status is fundamentally sex discrimination for failing to conform to gender stereotypes—an issue already determined to fall within Title VII’s scope.

In its analysis, the majority used the example of an employer who has a policy of firing any employee who is known to be gay. According to the Court, if a model employee brings a female spouse to an office holiday party and the employee is then fired due to also being female rather than male, the employer discriminated on the basis of sex, even if the intent was to discriminate on the basis of sexual orientation.

Similarly, the Court reasoned that an employer cannot discriminate against one of two otherwise identical female employees because she was identified as a male at birth. In doing so “the employer intentionally penalizes a person identified as male at birth for traits or actions that it tolerates in an employee identified as female at birth.” Accordingly, such discrimination is indistinguishable from sex discrimination.

Justice Samuel Alito, joined by Justice Clarence Thomas, authored one of two dissenting opinions. Justice Alito’s primary points of disagreement with the majority were: (1) the definition of “sex,” as understood by the legislators who authored Title VII, does not include sexual orientation or transgender status; and (2) Congress has had opportunities to amend Title VII to expressly include such protections but has failed to do so.

Justice Brett Kavanaugh’s dissent relied on his interpretation of the “ordinary meaning” of Title VII, which he concluded does not include protections for sexual orientation or transgender status. As such, Justice Kavanaugh reasoned it was not the Court’s role to expand the scope of Title VII. Despite his disagreement with the majority, Justice Kavanaugh’s dissent concluded with a congratulatory note to those he would deny Title VII’s protections, “Millions of gay and lesbian Americans have worked hard for many decades to achieve equal treatment in fact and law. They have exhibited extraordinary vision, tenacity, and grit—battling often steep odds in the legislative and judicial arenas, not to mention in their daily lives. They have advanced powerful policy arguments and can take pride in today’s result.”

The upshot of the Court’s Bostock decision is effectively an expansion of Title VII’s antidiscrimination protections to LGBTQ employees. While many employers already have policies prohibiting discrimination because of sexual orientation and/or transgender status, this decision presumably authorizes EEOC charges and Title VII claims for such discrimination.

© 2020 Dinsmore & Shohl LLP. All rights reserved.

For more on discrimination protections see the National Law Review Civil Rights law section.

SBA Rulemaking and Guidance Challenged in Federal Lawsuits in Connection with PPP Loan Guidance

The Coronavirus, Aid, Relief, and Economic Security Act (the “CARES Act”) was signed into law by the President on March 27, 2020. Title I of the CARES Act, named “Keeping American Workers Employed and Paid” by Congress, appropriated $659 billion for loans guaranteed by the Small Business Administration (“SBA”) under the Paycheck Protection Program (“PPP”).

Section 1114 of the CARES Act instructs the SBA to issue regulations “to carry out this title and the amendments made by this title” within fifteen days and without regard to the usual notice requirements, which the SBA did in the form of Frequently Asked Questions (the “FAQs”). 15 U.S.C. §§ 9001(1), 9012.

While ostensibly intended to clarify uncertainty in the CARES Act, two recent federal lawsuits challenge certain rulemaking and guidance promulgated by the SBA. The question before the courts is whether such rulemaking and guidance is a lawful interpretation of the CARES Act or, as the plaintiffs argue, amounts to illegal rulemaking.

Agencies are prohibited by the Administrative Procedures Act from taking action “in excess of statutory jurisdiction, authority, or limitations, or short of statutory right.” 5 U.S.C. § 706(2)(C). The validity of an agency’s interpretation of a statute is reviewed by a court using the two-step framework outlined in the landmark case, Chevron, U.S.A., Inc. v. Natural Res. Defense Council, Inc., 467 U.S. 837 (1984). The first question reviewed in the Chevron analysis is, “whether Congress has directly spoken to the precise question at issue. If the intent of Congress is clear, that is the end of the matter; for the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress.” Chevron, 467 U.S. at 842–43.

The plaintiffs argue that certain elements of the SBA guidance did not give effect to the unambiguously expressed intent of Congress and, as a result, are unlawful and unenforceable.

DV Diamond Club of Flint v. SBA

DV Diamond Club of Flint LLC (“DV Diamond”) is a strip club in Flint, Michigan, which feared that it would be denied a PPP loan by lenders as a result of guidance from the SBA that is not consistent with the CARES Act. DV Diamond’s initial complaint, dated April 8, 2020, was amended on April 17, 2020 to add forty-one new co-plaintiffs (collectively with DV Diamond, the “Plaintiffs”), each of which claims to operate a legal sexual oriented business which meets the eligibility requirements under the CARES Act. The Plaintiffs argue that the CARES Act is unambiguous as to what businesses are eligible for PPP loans and the SBA, therefore, has no right to assert additional eligibility requirements or disqualifiers. See DV Diamond Club of Flint, LLC v. U.S. SBA, 20-cv-10899, 2020 U.S. Dist. LEXIS 82213, at *27 (E.D. Mich. May 11, 2020).

The U.S. District Court for the Eastern District of Michigan (the “District Court”) issued an injunction in favor of the Plaintiffs, noting that Congress unambiguously stated that the SBA may not exclude from eligibility for a PPP loan guarantee a business that met the CARES Act’s size standard for eligibility. Id. at *27.

The District Court agreed with the Plaintiffs that, “under step one of Chevron that the PPP Ineligibility Rule conflicts with the PPP and is therefore invalid.” Id. at *42.

“Congress provided temporary paycheck support to all Americans employed by all small businesses that satisfied the two eligibility requirements—even businesses that may have been disfavored during normal times.” Id. at *4-5.

The Sixth Circuit Court of Appeals denied the SBA’s motion for a stay of the injunction, holding that the relevant factors, including the Plaintiff’s likelihood success, weighed in favor of the Plaintiff. DV Diamond Club of Flint, LLC v. SBA, No. 20-1437, 2020 U.S. App. LEXIS 15822, at *8 (6th Cir. May 15, 2020).

Zumasys, Inc. v. SBA

Zumasys and two affiliated companies (collectively, “Zumasys”) received PPP loans but are concerned that they may subsequently be deemed ineligible as a result of “improper, and legally impermissible, underground regulation” promulgated by the SBA. (Zumasys, Inc. v. U.S. SBA et al., Dkt. No. 20-cv-008511, Dkt. 1 (the Zumasys Complaint) ¶ 58.)

Zumasys claims to have acted in reliance on the CARES Act by obtaining—and spending—what they expected to be forgivable PPP funds under the terms of the CARES Act rather than furloughing or terminating their employees. Subsequently, guidance set forth in questions 31 and 37 of the SBA’s Frequently Asked Questions, according to Zumasys, might require their loans to be repaid. Zumasys claims that being forced to repay their loans will place them in a worse financial position than had it never sought the PPP funds.

The SBA’s “credit elsewhere” test, which requires a borrower to demonstrate that the needed financing is not otherwise available on reasonable terms from non-governmental sources, was expressly excluded as an eligibility requirement to obtain a PPP loan by Congress. Zumasys alleges, however, that the FAQs “purport to re-impose the “credit elsewhere” requirement in contravention of” the CARES Act. (Id. ¶ 66.)

As a result, in an argument similar to that made by DV Diamond and its co-plaintiffs, Zumasys asserts that the FAQs “are not in accordance with the law and exceed Defendants’ authority under the CARES Act,” and asks that the SBA should be enjoined from enforcing them by the court. (Id.)

Subsequent to the filing of the Zumasys lawsuit, on May 13, 2020, the SBA issued guidance in question 46 in the FAQs that any borrower that, together with its affiliates, received PPP loans with an original principal amount of less than $2 million will be deemed to have made the required certification concerning the necessity of the loan request in good faith.

While this development, on its face, would seem to alleviate the concerns of Zumasys, a great deal of uncertainty remains for borrowers in connection with the guidance that has been released by the SBA since the passing of the CARES Act into law. Furthermore, there is no guarantee that subsequent guidance from the SBA will not contradict the guidance currently being relied upon, and in FAQ 39 the SBA noted that it will review all loans in excess of $2 million and in subsequent rulemaking it noted that with respect to a PPP Loan of any size, the “SBA may undertake a review at any time in [the] SBA’s discretion.”

Conclusion

The challenges by DV Diamond, Zumasys and other plaintiffs will hinge on whether or not the applicable courts determine that the guidance issued by the SBA is inconsistent with the unambiguously expressed intent of Congress.

To the extent that borrowers and applicants continue to believe that problematic discrepancies exist between the law and guidance being delivered by the SBA, and the SBA subsequently determines that a borrower is ineligible for a PPP loan or forgiveness of such loan, the courts may in the future be called upon again to apply the Chevron analysis to the SBA’s actions in connection with the PPP.

The views and opinions expressed in this article are those of the authors and do not necessarily reflect those of Sills Cummis & Gross P.C.

© Copyright 2020 Sills Cummis & Gross P.C.
For more on SBA’s PPP loans, see the National Law Review Coronavirus News section.

Waters of the United States Litigation: Practical Considerations for the Regulated Community

A familiar list of states[1] are suing the Trump administration for revising the “waters of the United States” definition that is used to create the Clean Water Act (“CWA”) regulatory programs. The lawsuit is pending before the U.S. District Court for the Northern District of California.  California v. Andrew Wheeler, Civil Action No. 3:20-cv-03005.  There is also a predicable list of the other states[2] in the litigation supporting the “Navigable Waters Protection Rule:  Definition of the United States” promulgated on April 21, 2020.  85 Fed. Reg. 22,250. While we await the impact of litigation and ruling on the request for a stay, the rule becomes effective on June 22, 2020.

The complaint for declaratory and injunctive relief in this litigation provides a road map for the legal and regulatory challenges ahead for the regulated community and agencies implementing CWA programs that rely on the definition for “Waters of the United States” aka WOTUS.  The following provides insights as to how to support a strong CWA with the new WOTUS definition.

Upset of Existing Regulatory Programs.  Challenging states/cities express concern over regulation of discharges to WOTUS (NPDES), water quality standards (TMDLs), 401 certifications (NWPs), and control of oil spills (SPCC) as the result of the new WOTUS definition.  These are the programs that are relied upon by the regulated community to operate, maintain compliance, and develop new facilities.

Those seeking CWA permits/authorizations pursuant to the new WOTUS rule should consider enhancing their public submittals with documentation supporting policy decisions as protective of WOTUS uses.  Voluntary reports, studies and data demonstrating protections and regulatory successes, in addition to routine reporting and recordkeeping, would be constructive in building confidence in the program changes and in defending against regulatory and statutory challenges.

Too Narrow a Definition.  Challengers assert the new definition for WOTUS is narrow and excludes “waters long understood as within CWA’s protections.”  They assert that ephemeral streams and many wetlands are excluded.  The multi-step deliberative process that the former WOTUS regulatory program embraced resulted in the unfortunate inability to make timely decisions about regulatory authorizations.  The tangible impact of the clarity of the new definition is the ability to engage in thoughtful analysis and decide how best to manage WOTUS protections.

In support of the clarity found in the new WOTUS rule, there is a need to demonstrate that the definition promotes the Clean Water Act mission.  The regulated community needs to support the development of objective assessments that demonstrate this point to help educate about the effectiveness of the definition in meeting the CWS objective to “restore and maintain the chemical, physical, and biological integrity of the Nation’s waters.”

Rapanos “Significant Nexus” Concurrence.   Challengers assert the U.S. Supreme Court Rapanos decision that sets forth Justice Kennedy’s “significant nexus” concurrence should have been maintained in the definition, rather than implement the plurality opinion as was done in the new WOTUS definition.

The WOTUS rule of 2020 notes that “Since Rapanos, litigation has continued to confuse the regulatory landscape. See, e.g., ECOS Memorandum at 2-23. The Supreme Court also has twice weighed in on topics related to the agencies’ implementation of their authorities under the CWA to help clarify federal authority in this area. In each case, members of the Court noted the longstanding confusion regarding the scope of federal jurisdiction under the CWA and the importance of providing clear guidance to the regulated community.” 85 Fed. Reg. 22,250, 22,257.

The CWA becomes a statute unable to move if its programs are not capable of implementation, as the “significant nexus” analysis demonstrated.  The regulated community can facilitate this issue by working with all stakeholders to develop in the near-term reports and analyses about the measurable successes of the WOTUS definition rule.

Neighbor Jurisdiction Impacts.  Challengers express concern about jurisdictions upstream that may not be as protective of water adversely impacting downstream jurisdictions.  They assert a need for a national floor for protecting water to avoid adverse impacts on downstream states.

The regulated community has a shared interest with the challengers in a CWA regulatory program that is dependable and has reliable outcomes.  The difference in perspective is the challengers do not have confidence in states’ abilities to protect their waters, although all states are required to demonstrate effective CWA programs to the federal agencies.  The regulated community needs to work in partnership with the state and federal agencies to support successful outcomes to refute the fear that downstream jurisdictions must be concerned.

Flow in a typical year.  A tributary, lake, pond, or impoundment must contribute flow in a “typical year” directly to traditional navigable waters (e.g., through other tributaries, lakes, ponds, impoundments or adjacent wetlands).  Tributaries must be either perennial (continuously flowing all year round) or intermittent (continuously flowing during certain times of the year and not just in response to precipitation).  The challengers assert the definition for typical year is not well articulated. “Typical year” is defined to mean “when precipitation and other climatic variables are within the normal periodic range (e.g., seasonally, annually) for the geographic area of the applicable aquatic resource based on a rolling thirty-year period.” The 2020 Rule does not identify which “other climatic variables” should be considered, or what is the “geographic area of the applicable aquatic resource.”

The challengers share with everyone a distaste for vague outcomes, a common human sentiment.  The previous WOTUS rule encompassed a myriad of steps embedded with complexities that defied any reliable or predictable outcome.  The need to define “typical year” to create a comprehensible result falls well within the acknowledged need for common sense policy.

Excluded Waters.  The challengers assert that the WOTUS definition excludes:  ephemeral waters (those flowing only in direct response to precipitation) and their adjacent wetlands, “interstate” waters as a separate category of the “waters of the United States,” and therefore excludes many waters that cross state borders;  and many wetlands that are near other jurisdictional waters but lack a physical or surface hydrological connection to them.

All stakeholders need an operable method to delineate a definition for WOTUS for the purpose of applying the CWA programs.  Objecting to a program that is unclear is a valid concern when working to promote a sustainable Clean Water Act.  Working against regulatory clarity seems misguided.  Leadership is welcomed in educating about sustainable regulation as opposed to stalled regulation.

[1] The following states have sued EPA and the Army Corps of Engineers over the recent definition for “waters of the United States.”  Plaintiffs are:  California, New York, Connecticut, Illinois, Maine, Maryland, Michigan, New Jersey, New Mexico, North Carolina, Oregon, Rhode Island, Vermont, Washington, Wisconsin, Massachusetts, Virginia, the North Carolina Department of Environmental Quality, the District of Columbia, and the City of New York.

[2] Intervenors for the Defendant Federal Agencies include:  Pacific Legal Foundation, Georgia, Wyoming, Alabama, Texas, Indiana, Mississippi, Alaska, Idaho Department of Environmental Quality, Oklahoma, Arkansas, Idaho, Kansas, Kentucky, Louisiana, Missouri, Montana, North Dakota, South Carolina, South Dakota, Utah, and West Virginia.

© Steptoe & Johnson PLLC. All Rights Reserved.
For more on Waters of the United States, see the National Law Review Environmental Energy & Resources law section.

Federal Courts Side With Strip Clubs in Opposing the SBA’s Ineligibility Rules for the Paycheck Protection Program, Possibly Signaling a Broader Trend

Recent rulings from federal courts enjoined the US Small Business Administration (SBA) from applying its April 2, 2020 Interim Final Rule (April 2 IFR) to limit the types of businesses that can participate in the Paycheck Protection Program (PPP) under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). Some of these rulings are expressly limited to the named plaintiffs that had been denied PPP loans and do not directly impact any other businesses that have or might apply for a PPP loan. Irrespective of any limitations in these cases, such decisions may signal a broader trend. In increasing numbers, federal courts are agreeing with arguments made by small businesses facing COVID-19-related challenges that the SBA’s PPP business eligibility limitations are inconsistent with Congress’ intention to help “any business concern” during this unprecedented time.

Financial services businesses that are deemed ineligible under the April 2 IFR need to pay close attention to cases that challenge the SBA’s incorporation of its existing list of “prohibited businesses” into eligibility requirements for a PPP loan. Even without court rulings, it also is possible (although not likely) that Congress or the SBA could suspend or revise the April 2 IFR to broaden PPP eligibility to include some or all of the currently designated “prohibited businesses.”

This advisory will explore:

  • the SBA’s April 2 IFR restricted eligibility in the PPP to certain financial services businesses that were ineligible for SBA-guaranteed loans under existing federal programs;

  • a recent Sixth Circuit ruling challenging the April 2 IFR as well as other federal court cases may signal a trend by federal courts to adhere to the text of the CARES Act; and

  • whether other federal courts will follow the Sixth Circuit’s view, or whether Congress or the SBA will suspend or revise the April 2 IFR to broaden PPP eligibility.

The April 2 IFR and Subsequent SBA Rules and Guidance

The PPP was one of several measures enacted by Congress under the CARES Act to provide small businesses with support to cover payroll and certain other expenses for an eight-week period due to the economic effects of the COVID-19 pandemic. As noted in a prior Katten Financial Markets and Funds advisory, the SBA published the April 2 IFR on the evening before lenders could accept PPP applications, determining that various businesses, including some financial services business, were ineligible to apply for PPP loans under the CARES Act.1

The April 2 IFR limited the types of businesses eligible for the PPP by specifically incorporating an existing SBA regulation and guidance document that lists the types of businesses that are ineligible from applying for Section 7(a) SBA loans. In particular, the April 2 IFR provides, in part, that: “Businesses that are not eligible for PPP loans are identified in 13 CFR 120.110 and described further in SBA’s Standard Operating Procedure (SOP) 50 10, Subpart B, Chapter 2.”2

Some of the ineligible financial services businesses listed in the SBA’s Standard Operating Procedure 50 10 (SOP) include, without limitation:

  • banks;
  • life insurance companies (but not independent agents);
  • finance companies;
  • investment companies;
  • certain passive businesses owned by developers and landlords, which do not actively use or occupy the assets acquired or improved with the loan proceeds, and/or which are primarily engaged in owning or purchasing real estate and leasing it for any purpose; and
  • speculative businesses that primarily “purchas[e] and hold[ ] an item until the market price increases” or “engag[e] in a risky business for the chance of an unusually large profit.”

With respect to last category in this list, the SBA provided further clarity regarding certain investment businesses and speculative businesses that were applying for PPP loans. In an April 24, 2020 Interim Final Rule (April 24 IFR), the SBA expressly clarified that hedge funds and private equity firms are investment and speculative businesses and, therefore, are ineligible to receive PPP loans.3 However, the April 24 IFR created an exception for portfolio companies of private equity firms, which were deemed eligible for PPP loans if the entities met the requirements for affiliated borrowers under the April 2 IFR.4

Recent Sixth Circuit Case

As noted above, the SBA’s SOP did not only deem financial services businesses ineligible to receive PPP loans. Other types of businesses, including without limitation, legal gambling businesses, lobbying firms, businesses promoting religion and businesses providing “prurient sexual material” also were deemed ineligible. Believing that these limitations were inconsistent with a plain reading of the text of the CARES Act, some of these businesses have challenged the SBA’s restrictions imposed pursuant to the April 2 IFR.

On May 11, 2020, the US District Court for the Eastern District of Michigan preliminarily enjoined the SBA from enforcing the April 2 IFR to preclude sexually oriented businesses from PPP loans under the CARES Act.5 Plaintiffs were primarily businesses that provided lawful “clothed, semi-nude, and/or nude performance entertainment,” which were considered ineligible businesses for the PPP under the April 2 IFR due to their “prurient” nature.6 The district court found that the CARES Act specifically broadened the class of businesses that are PPP eligible,7 determining that it was clear from the text of the statute that Congress provided “support to all Americans employed by all small businesses.”8 The district court, however, limited the injunction to the plaintiffs and intervenors in the case, noting that it was “not a ‘nationwide injunction’ and did not restrict any future action the SBA may take in connection with applications for PPP loans.”9 The SBA appealed to the US Court of Appeals for the Sixth Circuit and requested a stay of the injunction.10

The Sixth Circuit ultimately denied the SBA’s stay, and agreed with the district court’s interpretation of the CARES Act’s eligibility requirements.11 Specifically, the Sixth Circuit held on May 15 that the CARES Act conferred eligibility to “any business concern,” which aligned with Congress’s intent to provide support to as many displaced American workers as possible. The SBA pointed out that the CARES Act explicitly listed “nonprofit organizations” as eligible for PPP loans, even though “they are ineligible for ordinary SBA loans.”12 The SBA argued that if Congress wanted to include previously ineligible businesses for PPP loans, like sexually oriented businesses, the CARES Act would have listed such entities.13 The Sixth Circuit stated that it was “necessary to specify non-profits because they are not businesses,” which further supported the district court’s expansive interpretation of the CARES Act.14

The Sixth Circuit’s opinion only requires the SBA to issue loans to the businesses that were a party to the underlying lawsuit. The ruling does not require the SBA to make PPP loans to any other businesses that are defined as ineligible in its April 2 IFR. However, as a practical matter, this opinion could be used to support a small business located in Ohio, Pennsylvania or Michigan (i.e., the states within the jurisdictional reach of the Sixth Circuit) in a federal court proceeding initiated prior to the submission of a PPP application requiring the SBA to defend its eligibility criteria in connection with such small business’s specific facts. (Note that an application should not be made without first obtaining a similar legal result as the small business applicant would not otherwise be able to make the certifications necessary to apply for a PPP loan.)

Cases in Other Circuits

In addition to the Sixth Circuit, several other federal courts have struck down the SBA’s imposition of its ineligibility criteria on PPP applicants engaged in sexually oriented businesses. For example, the US District Court for the Eastern District of Wisconsin on May 1 preliminarily enjoined the SBA from enforcing the April 2 IFR to preclude “erotic dance entertainment” companies from obtaining a PPP loan.15 The SBA argued that because Congress removed some conditions that would ordinarily apply to Section 7(a) SBA loans (such as the PPP eligibility for non-profits), “it must have intended for the SBA to enforce all other conditions.”16 Similar to the Sixth Circuit, the district court found the SBA’s interpretation “highly unlikely” given “Congress’s clear intent to extend PPP loans to all small businesses affected by the pandemic.”17 Additionally, the SBA failed to identify any purpose of either the CARES Act or Section 7(a) that is furthered by the SBA’s exclusion of sexually oriented businesses.18 The SBA appealed to the US Court of Appeals for the Seventh Circuit and requested a stay of the injunction pending appeal. The Seventh Circuit denied the request for a stay on May 20, 2020, but has yet to rule on the merits of the appeal.19

Implications

As of May 21, 2020, roughly $100 billion PPP funds are still available.20 In its recent statutory amendments to the PPP, Congress decided not to address PPP eligibility issues.21 Notwithstanding Congress’s decision not to take action on these issues more recently, financial services businesses deemed ineligible under SBA regulations for PPP loans under the CARES Act should still pay close attention to these cases and whether federal court rulings influence Congress or the SBA to revisit the April 2 IFR.22

1 See US Small Business Administration, Interim Final Rule: Business Loan Program Temporary Changes; Paycheck Protection Program, 85 Fed. Reg. 20811, (Apr. 15, 2020).

2 See Interim Final Rule at 8, citing 13 C.F.R. § 120.110 and Small Business Administration Standard Operating Procedure 50 10 Subpart B, Chapter 2.

3 See US Small Business Administration, Interim Final Rule: Business Loan Program Temporary Changes; Paycheck Protection Program – Requirements – Promissory Notes, Authorizations, Affiliation, and Eligibility, __ Fed. Reg.___, available.

4 According to the April 24 interim final rule, the affiliation requirements are waived if “the borrower receives financial assistance from an SBA-licensed Small Business Investment Company (SBIC) in any amount. This includes any type of financing listed in 13 CFR 107.50, such as loans, debt with equity features, equity, and guarantees. Affiliation is waived even if the borrower has investment from other non-SBIC investors.” Id.

5 DV Diamond Club of Flint, LLC, et al. v. SBA, et al., No. 20-1437 (6th Cir. Apr. 15, 2020).

6 Id. at 2.

7 DV Diamond Club of Flint LLC v. SBA, No. 20-cv-10899 (E.D. Mich. May 11, 2020), at 2. The district court stated that 15 U.S.C. § 636(a)(36)(D) of the CARES Act specifically “broadened the class of businesses that are eligible to receive SBA financial assistance.” Id. at 9. This section provides, in relevant part, that “‘[d]uring the covered period, in addition to small business concerns, any business concern . . . shall be eligible to receive a covered [i.e., SBA-guaranteed] loan’ if the business employs less than 500 employees or if the business employs less than the size standard in number of employees for the industry,” which is established by the SBA. Id. See also 15 U.S.C. §§ 636(a)(36)(D)(i)(I)-(II).

8 DV Diamond Club, No. 20-cv-10899 (E.D. Mich. May 11, 2020), at 2.

9 Id. at 45.

10 DV Diamond Club, No. 20-1437 (6th Cir. Apr. 15, 2020), at 1.

11 Id. at 4. The Sixth Circuit interpreted the CARES Act under the Supreme Court’s ruling in Chevron, U.S.A., Inc. v. Natural Res. Defense Council, Inc., 467 U.S. 837 (1984). Id. In Chevron, the Supreme Court stated that if a federal statute can be facially interpreted, “the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress.” Chevron, 467 U.S. at 842–43.

12 DV Diamond Club, No. 20-1437 (6th Cir. Apr. 15, 2020), at 5.

13 Id.

14 Id. US Circuit Judge Eugene E. Siler Jr. dissented, stating that the CARES Act was ambiguous and the district court’s injunction should be stayed to give time to decide on the merits. Id. at 6. He noted that the CARES Act requires “PPP loans to be administered ‘under the same terms, conditions and processes’” as the SBA’s section 7(a) loans, which would exclude sexually oriented businesses from PPP eligibility. Id. See also 15 U.S.C. § 636(a)(36)(B).

15 Camelot Banquet Rooms, Inc., et al. v. SBA, et al., No. 20-C-061 (E.D. Wis. May 1, 2020), at 27-28. A similar case, filed early May 2020, is currently pending in the US District Court for the Northern District of Illinois. See Admiral Theatre Inc. v. SBA et al., No. 1:20-cv-02807 (N.D. Ill May 8, 2020).

16 Camelot Banquet Rooms, No. 20-C-061 (E.D. Wis. May 1, 2010), at 15.

17 Id. at 16. In contrast to the Eastern District of Michigan, the Wisconsin federal court did not explicitly limit its injunction to the parties. In light of the potentially serious penalties for ineligible applicants, businesses that are ineligible for the PPP under the April 2 IFR should be cautious about applying for a PPP loan without exploring all options and consequences with counsel.

18 Id.

19Camelot Banquet Rooms, Inc., et al. v. SBA, et al., No. 20-1729 (7th Cir. May 20, 2020). In contrast to the Sixth and Seventh Circuit rulings, the US District Court for the District of Columbia denied an injunction to enjoin the SBA from making an eligibility determination for the PPP under the CARES Act. Am. Ass’n of Political Consultants v. SBA, No. 20-970 (D.D.C. April 21, 2020). Plaintiffs, a trade association of political consultants and lobbyists, argued that the denial of PPP loans under the SBA’s April 2 IFR due to the political nature of their businesses violated plaintiffs’ First Amendment rights. Id. at 1-2. The district court ruled that it was constitutionally valid for the SBA to decide “what industries to stimulate” with PPP loans. Id. at 11. The plaintiffs filed a notice of appeal on April 22, 2020. Am. Ass’n of Political Consultants, Notice of Appeal, ECF No. 22 (D.D.C. April 22, 2020).

20 Kate Rogers, More than half of small businesses are looking to have PPP funds forgiven, survey says, CNBC News (May 21, 2020), available at https://www.cnbc.com/2020/05/21/more-than-half-of-small-businesses-are-looking-for-ppp-forgiveness.html.

21 On June 3, 2020, Congress passed the Paycheck Protection Program Flexibility Act (“PPP Flexibility Act”), which modified certain provisions of the PPP. H.R. 7010, 116th Cong. (2020), available at https://www.congress.gov/bill/116th-congress/house-bill/7010/text?r=12&s=1. At a high level, the PPP Flexibility Act: 1) extends the PPP to December 31, 2020; 2) extends the covered period for purposes of loan forgiveness from 8 weeks to the earlier of 24 weeks or December 31, 2020; 3) extends the covered period for purposes of loan forgiveness from 8 weeks to the earlier of 24 weeks or December 31, 2020; 4) increases the current limit on non-payroll expenses from 25% to 40%; 5) extends the maturity date on the portion of a PPP loan that is not forgiven from 2 years to 5 years; and 6) defers payroll taxes for businesses that take PPP loans.

22 IFRs are subject to public comment under the Administrative Procedures Act. The particular comment period of the April 2 IFR expired on May 15, 2020.

©2020 Katten Muchin Rosenman LLP

For more on business’ PPP loan eligibility, see the National Law Review Coronavirus News section.

Hirst Spot Print Turned into Spots by MSCHF, Courtroom Artists Face New Challenge, Banksy Pays Homage to Hospital Workers

Still No LOVE in Robert Indiana’s Estate Battle

In the ongoing suit over the rights to Robert Indiana’s artworks, defendant Michael McKenzie, the founder of American Image Art, filed new counterclaims against the Morgan Art Foundation alleging that Morgan orchestrated “one of the most massive art frauds in history.” McKenzie argues that intellectual property rights were abandoned by Indiana decades ago and that the artist’s famous LOVE artwork is in the public domain. McKenzie further alleges that Morgan “fraudulently affixed” copyright to more than 1,000 sculptures worth more than $100 million and an additional million items valued at least $50 million in retail sales – Indiana did not affix a copyright symbol to his work when it was first published. McKenzie also seeks to invalidate two federal trademarks that Morgan registered for the design and reproduction of LOVE. Notably, several other counterclaims made by McKenzie and Indiana’s estate were dismissed in 2019. Morgan maintains that it has the rights to all images and sculptures that Indiana produced between 1960 and 2004, as well as the exclusive right to fabricate and sell certain sculptures, including LOVE, pursuant to agreements dating back to 1999. Morgan’s direct claim against McKenzie is over the sale of works it alleges were falsely attributed to Indiana.

As SCOTUS Moves Oral Arguments Online, Courtroom Artists Forced to Use Their Ears – and Imaginations – for Illustrations of Oral Arguments

The U.S. Supreme Court’s justices and their staffs are not the only people in the courtroom having to adapt. Court-appointed artists still capture the oral arguments, but must now rely on their ears and imaginations rather than their eyes to create the illustrations. The inability to be inside the courtroom during the arguments not only makes it difficult to paint a picture but also leaves lawyers in the dark as to the justices’ reactions to their arguments.

The Most Expensive Game of (Dis)Connect the Dots: A $30,000 Hirst Print Sold Off Spot by Spot

Damien Hirst created a spot print titled L-Isoleucine T-Butyl Ester. Now, MSCHF, a Brooklyn-based art collective, cut out each of the print’s 88 spots as part of the project called Severed Spots, created in protest against the practice of fractionizing the ownership of artworks. MSCHF sold off each of the spots for $480, generating a profit of about $12,000 over the $30,000 purchase price; in yet another example of an artwork’s value apparently growing as a result of its destruction (think Banksy’s Love Is in the Bin), they stand to gain even more as bidders line up to purchase leftover white paper. Our readers will remember MSCHF for auctioning off The Persistence of Chaos, a computer with the world’s most malicious viruses last year, among other news-making stunts/artworks. MSCHF also sold Jesus Shoes, custom Nike Air Max 97s with holy water from the River Jordan in the soles. Damien Hirst’s studio has not yet responded to this latest stunt by the collective.

Founder of Napster Involved in Suit Over Ownership of an Old Master Painting

Auction house Christie’s recent court filings to enforce an arbitration award reveal that art collector Sean Parker, founder of Napster and first president of Facebook, was embroiled in a dispute over a sale of Peter Paul Rubens’s A Satyr Holding a Basket of Grapes and Quinces with a Nymph (1620). In 2018, Parker acquired the artwork at a Christie’s auction for his foundation, after which the consignor of the artwork inexplicably sought to cancel the sale, despite making more than $1 million in profit. The consignor claimed that she tried to withdraw the painting before the auction took place. When the parties were unable to amicably resolve the dispute, it was submitted to arbitration. The arbitrator ruled that Christie’s complied with its contractual obligations and that Parker lawfully acquired the painting. The case highlights the legal and financial responsibilities of the parties involved in consigning an artwork to an auction house.

Former Paddle8 CEO Sued for Alleged Misappropriation of Funds

A group of creditors brought suit in the Southern District of New York, accusing former Paddle8 CEO Valentine Uhovski of engaging in acts of gross mismanagement and disloyalty, including alleged misappropriation of funds from the auctions to pay the company’s operating expenses. Uhovski has denied the allegations. Paddle8 filed for bankruptcy in March, following a separate suit by a nonprofit cinema group that alleged misappropriation of funds from a charity auction.

Mail Art Experiencing Revitalization

In recent months, Mail Art – a 1950s art movement centered around sending small-scale artworks via the postal service – has regained popularity. Artists have been reaching out via social media for submissions, and to date, hundreds of individuals have answered the call. The original idea was to create a form of artistic production that bypasses the traditional channels of art dissemination. The reborn interest in Mail Art is “creating a sense of connectivity” while allowing for people stuck in their homes to take a break from their screens.

EUROPE

INTERPOL Recovers 19,000+ Artifacts in a Massive Operation Spanning 103 Countries

More than 300 INTERPOL investigations coordinated between 103 countries resulted in recovery of more than 19,000 artifacts. Recalling the work of the Monuments Men – unlikely World War II heroes who saved many of Europe’s art treasures – the investigations were focused on criminal networks that deal in artworks looted from war-torn countries as well as artifacts stolen from archeological excavations and museums. The success of the mission highlights the need for global cooperation in fighting the trafficking of cultural goods.

MoMA Voices Concerns Over Norway’s Handling of Picasso Murals

The Norwegian government is in the process of demolishing a government building in Oslo that features Pablo Picasso’s murals sandblasted onto the concrete walls. While plans have been made to relocate the artworks, many are concerned that once moved, the murals will crack. The MoMA letter, published in the Norwegian press, expresses grave concerns over the preservation of the murals and emphasizes their significance to the art community. In addition, the petition to preserve the building holding the murals has garnered more than 47,000 signatures.

Van Eyck Exhibition Organizers Argue Coronavirus Triggers Cancellation Policy

Organizers of the largest exhibition ever dedicated to the Flemish Old Master Jan Van Eyck will distribute refunds to 144,000 ticket holders who were unable to attend due to early closure following the coronavirus outbreak. The organizers are seeking coverage from their cancellation insurer for the refunds of more than €3.5 million.

Counterfeit Artwork Seized at Heathrow Airport Part of a Larger Problem

The British Museum’s inspection revealed that hundreds of what looked to be Middle Eastern artifacts intercepted last July by an officer at Heathrow Airport were fakes. While the items were discovered to be counterfeit, they had the potential to be sold for thousands of dollars to unsuspecting buyers.

Croatia Rushes to Save Valuable Pieces of Art

While the world deals with the ongoing coronavirus pandemic, Croatia experienced a 5.4 magnitude earthquake in its capital, Zagreb. The earthquake damaged some 26,000 buildings, palaces, university buildings and hospitals. The Museum of Decorative Arts, which planned on celebrating its 140th anniversary, suffered a roof collapse during the earthquake. While the building has been classified as unsafe for use, the Museum has been expeditiously removing many fragile objects, even while the aftershocks continued. Many other pre–20th century buildings also sustained damage.

Banksy Pays Homage to Hospital Workers

As a tribute to the National Health Service and health care workers during this pandemic, renowned street artist Banksy created an artwork titled Game Changer (2020), which he donated to England’s Southampton General Hospital. The piece came with a note to the health care workers that read: “Thanks for all you’re doing. I hope this brightens the place up a bit, even if it’s only black and white.” Just days after the artwork was installed, an opportunistic thief wearing a hazmat suit and armed with a drill was caught attempting to steal it.

ASIA

Archaeologists Uncover Further Evidence of Vital Role of Women in Ancient Mongolian Society

Archaeologists discovered 1,500-year-old skeletons of women warriors in northern Mongolia, near China – recalling the story of Hua Mulan, originally described in the Ballad (Ode) of Mulan composed in the fifth or sixth century CE, and appearing as the main character in the 1998 animated Disney film. A study of the skeletons revealed the two women to be skilled in archery and horseback riding. The skeletons were found in a cemetery at the Airagiin Gozgor archeological site. Disney has been planning to release a live-action adaptation of Mulan, currently scheduled for July 24, social distancing guidelines permitting.

 

© 2020 Wilson Elser

“Caveat Emptor”: New York Bankruptcy Court Disallows Bankruptcy Claims Purchased from Recipients of Avoidable Transfers; Is Enron Going, Going, . . . ?

A recent Bankruptcy Court decision, In re Firestar Diamond, Inc., out of the Southern District of New York (“SDNY”) by Bankruptcy Judge Sean H. Lane, disallowed creditors’ bankruptcy claims purchased from sellers who allegedly received (and had not repaid) avoidable preferences and fraudulent transfers from the debtors.1 Judge Lane provides a cogent warning to claims purchasers that they bear the risk of Bankruptcy Code section 502(d) disallowance.

Judge Lane based the Firestar Diamond decision on Bankruptcy Code section 502(d), which mandates disallowance of claims of an entity that has received property that the estate may recover (e.g., avoidable transfers) unless that entity or its transferee has repaid the avoidable or recoverable amount.2  Further, in so ruling, Judge Lane aligned his Court with the view of the Third Circuit Court of Appeals in In re KB Toys Inc.3  There, when faced with the same issue, the Third Circuit held that the taint of section 502(d) disallowance risk travels with the claim itself and the taint cannot be cleansed through a subsequent transfer of the claim to a third-party transferee.

Notably, in reaching its holding in Firestar Diamond, Judge Lane rejected a holding by a District Court in its own district.  Thirteen years ago, in the aftermath of the Enron bankruptcy, District Court Judge Shira Scheindlin held that Bankruptcy Code section 502(d) is a “personal disability and does not travel with the ‘claim,’ but with the ‘claimant.’”  In a decision that was regarded as a boon to the secondary bankruptcy claims trading market, Judge Scheindlin ruled that purchasers of claims (not mere assignees) would take free from the risk of section 502(d) disallowance.4 The District Court vacated the Bankruptcy Court’s order disallowing claims and remanded to determine the nature of the transfer.  If the transfer were a sale, rather than an assignment, it would not be disallowed under section 502(d).5  But the Enron decision found few adherents.  Firestar Diamond joins a lengthening line of decisions criticizing or declining to follow it.

Some risk mitigation suggestions are set forth in the “Implications” section below.

Background:

In Firestar Diamond, the Debtors were three wholesalers of jewelry – Firestar Diamond, Inc., Fantasy, Inc., and A. Jaffee, Inc. (collectively, “Firestar” or the “Debtors”) – who sold mainly to department stores and specialty chain stores in the United States.  Firestar filed for Chapter 11 protection in February of 2018 in the SDNY in the “shadows of an alleged massive fraud” conducted by Firestar’s owner, Nirav Modi, who allegedly used a number of shadow entities (“Non-debtor Entities”) to pose as independent third parties in sham transactions in order to obtain billions of dollars in bank financing.

The SDNY Bankruptcy Court appointed an examiner to look into these allegations.  The examiner found “substantial evidence” of the Debtors’ “knowledge and involvement” in the alleged criminal conduct.  As a result, the court appointed a Chapter 11 trustee to administer the Debtors’ estates.6

A number of banks filed proofs of claims in the Chapter 11 case.  The banks’ claims were not based on their dealings with the Debtors.  Instead, the banks’ claims were based on amounts that the Debtors owed to the Non-debtor Entities, which had pledged their receivables or sold their invoices to the banks at a discounted price for amounts the Debtors owed.7 

The Chapter 11 trustee objected to the banks’ claims under section 502(d) because the claims had been acquired from claim sellers who had received fraudulent transfers and preferences from the Debtors.  The banks opposed the trustee’s argument based on Enron, arguing instead that “disallowance under Section 502(d) is a personal disability and does not travel with the ‘claim,’ but with the ‘claimant’” and that the banks had “acquired rights to payment from the Debtors through a ‘sale’ rather than an ‘assignment’.” Therefore, the claims had been washed clean.8

In contrast, the trustee argued that “sale” or “assignment” was of no import and urged the Court to reject Enron and follow rulings by other courts, including the Third Circuit’s decision in KB Toys.  In the trustee’s view, the banks’ claims should be treated the same as if they had been filed by the Non-debtor Entities and disallowed.

Ultimately, Judge Lane agreed with the trustee and held that the banks’ claims should be disallowed because section 502(d) focuses on the claims themselves rather than who holds them. The original claims were disallowable and, therefore, remained disallowable even after their sale to the banks.

Enron and KB Toys:

Enron and KB Toys represent opposing views interpreting section 502(d).  Generally, Enron attributed disallowance under section 502(d) to the claimant rather than a feature that transfers with a claim. On the other hand, KB Toys viewed section 502(d) disallowance as an attribute of the claim and therefore a feature that travels with the claim upon transfer.

In Enron, the court also held that when a claim is transferred, the “nature of that transfer” will dictate whether there may be a disallowance under section 502(d).  Indeed, a transfer of a claim by assignment would allow the personal disability to transfer with the claim because an assignee “stands in the shoes of the assignor” and would, therefore, take on the transferred property with “whatever limitations it had in the hands of the assignor[.]”  Meanwhile, a transfer by a sale would allow the purchaser only to receive the claim, washing the claim of the disability.  Judge Scheindlin reasoned that recovery of property under the threat of section 502(d) disallowance would not be achieved if the claim was held by a creditor who had not received the preference.9

KB Toys rejected the distinction between “assignment” and “sale,” noting that there is no support for this distinction in the Bankruptcy Code.  The Third Circuit concluded that “claims that are disallowable under [section] 502(d) must be disallowed no matter who holds them.”10  The Third Circuit reasoned that allowing a claim originally held by the recipient of a fraudulent or preferential transfer to be washed clean of section 502(d) disabilities would “contravene” the purpose of section 502(d), “which is to ensure equality of distribution of estate assets.”11  If the original claimant could rid the claim of its disabilities by selling the claim to a transferee, trustees would be “deprive[d] . . . of one of the tools the Bankruptcy Code gives trustees to collect assets—asking the bankruptcy court to disallow problematic claims.”12

A number of other courts and scholars alike have agreed with the Third Circuit, thereby concluding that section 502 follows the claim rather than the claimant.13

In re Firestar Diamond:

Judge Lane’s recent decision in Firestar Diamond continues that trend.  Indeed, Firestar Diamond adopted KB Toys’ reasoning and rejected the banks’ position and reliance on Enron.14  Judge Lane, focusing on the claims rather than the claimants, granted the trustee’s section 502(d) claim objections.  The banks’ claims were tainted by fraudulent and preferential transfers received by participants in Firestar’s bank fraud scheme.  Those Non-debtor Entities could not cleanse their other claims against the debtor by selling them to third parties, unless they repaid the avoidable transfers.

In addition, Judge Lane rebuffed the banks’ argument that disallowance of their claims would “wreak havoc in the claims trading market or unfairly punish good faith transferees.”  Rather, the Court explained that it would be “inequitable” to favor the banks over other creditors.15

Following KB Toys, Judge Lane thus concluded that claims purchasers should bear that risk because (i) they voluntarily chose to participate in the bankruptcy and were aware of the risks of doing so, and (ii) they are able to mitigate that risk through due diligence and including an indemnity clause in the transfer agreement.  On the other hand, other creditors in a bankruptcy “have no way to protect themselves against the risk that claims with otherwise avoidable transfers will be washed clean by a sale or assignment.”16

Implications

Firestar Diamond continues the trend of disallowing creditor claims acquired from sellers who received avoidable or preferential transfers from the debtor. In light of yet another decision coming out this way, claims purchasers need to transact with eyes wide open and be mindful of potential consequences pursuant to section 502(d) of the Bankruptcy Code.

Duly informed claims purchasers may mitigate some risk by, among other things, considering the following measures:

  • Conduct due diligence with the goal of aiming to minimize disallowance risk under section 502(d) by investigating and inquiring into the seller’s relationship and transactions with the debtor.
  • Consider including protections in claim transfer agreements, such as indemnification language in the event of a claim objection based on section 502(d).
  • Consider documenting transfers as “sales” rather than assignments to take advantage of whatever protection or benefit the Enron rationale may still bestow and provide.

1   In re Firestar Diamond, Inc., et al., No. 18-10509 (SHL), 2020 WL 1934896 (Bankr. S.D.N.Y. Apr. 22, 2020) (“Firestar Diamond”).

2   Section 502(d) provides, in part, “[T]he court shall disallow any claim of an entity from which property is recoverable under section 542, 543, 550, or 553 of this title or that is a transferee of a transfer avoidable under section 522(f), 522(h), 544, 545, 547, 548, 549, or 724(a) of this title, unless such entity or transferee has paid the amount, or turned over any such property, for which such entity or transferee is liable under section 522(i), 542, 543, 550, or 553 or this title.”

3   736 F.3d 247 (3d Cir. 2013) (“KB Toys”).

4 Judge Scheindlin limited protection from section 502(d) disallowance to claims held by creditors who acquired their claims by “sale” rather than “assignment.”  The District Court reasoned that a transfer by assignment will not grant the assignee more rights than possessed by the assignor – an assignee “stands in the shoes of the assignor” and takes with the assignor’s limitations.  379 B.R. at 435.  But a claim that is “sold” is not subject to the personal disabilities of the transferor.  Id. at 436.

5   In re Enron Corp., 379 B.R. 425, 445-46 (S.D.N.Y. 2007) (“Enron”) (“the nature of the transfer will determine whether [the] claims can be subject to . . . disallowance based on [Debtor]’s conduct”).  The Third Circuit, other courts, and bankruptcy commentators have questioned the distinction between “sale and “assignment,” finding it “problematic” and unsupported by state law.  See KB Toys, 736 F.3d at 254; Firestar Diamond, 2020 WL 1934896 at *9-12.

6   Firestar Diamond, 2020 WL 1934896 at *2-3.

7   Id. at *4 n.3.

8   Id. at *4-6.

9   Enron, 379 B.R. at 443 (The purpose of section 502(d) is to “coerce the return of assets obtained by preferential transfer. That purpose would not be served if a claim in the hands of a claimant could be disallowed even where that claimant had never received the preference to begin with, and as a result, could not be coerced to return it. It seems implausible that Congress would have intended such a result.”).

10 KB Toys, 736 F.3d at 252.

11 Id. at 252.

12 Id.

13 See Firestar Diamond, 2020 WL 1934896 at *10-11 (collecting cases and scholarly articles); In re Motors Liquidation Co., 529 B.R. 520 (Bankr. S.D.N.Y. 2015); In re Wash. Mut., Inc., 461 B.R. 200 (Bankr. D. Del. 2011), vacated in part on other grounds, 2012 WL 1563880 (Bankr. D. Del. Feb. 24, 2012); Adam J. Levitin, Bankruptcy Markets: Making Sense of Claims Trading, 4 Brook. J. Corp. Fin. & Com. L. 67, 92 (2009); Jennifer W. Crastz, Can a Claims Purchaser Receive Better Rights (Or Worse Rights) Than Its Transferor in a Bankruptcy?, 29 Cal. Bankr. J. 365, 637 (2007); Roger G. Jones & William L. Norton, III, Norton Creditor’s Rights Handbook § 8:8 (2008).

14 Firestar Diamond, 2020 WL 1934896 at *9.

15 Id.

16 Id. at *13-14.

© Copyright 2020 Cadwalader, Wickersham & Taft LLP

Veterans Affairs Case Offers Clarification on WPA Burden of Proof

In Sistek v. Dep’t of Veterans Affairs, 955 F.3d 948, 954 (Fed. Cir. 2020), the Federal Circuit clarified a federal whistleblower’s burden of proving retaliation when the discrimination he alleges is not specifically identified as a prohibited personnel action in the Whistleblower Protection Act of 1989 (“WPA”), 5 U.S.C. § 2302(b)(8). The WPA protects federal employees who disclose evidence of illegal or improper government activities. Under the WPA, an agency may not take or threaten to take certain personnel actions because of a protected disclosure by an employee.

This blog reviews the elements of a WPA claim, then discusses how Sistek affects these proof requirements when the retaliation consists, in part, of subjecting the employee to an internal investigation.

Background on the Whistleblower Protection Act

To state a claim under WPA, an employee must allege that (1) there was a disclosure or activity protected under the WPA; (2) there was a personnel action authorized for relief under the WPA; and (3) the protected disclosure or activity was a contributing factor to the personnel action. See 5 U.S.C. § 1221(e)(1). If the appellant makes out a prima facie case, the agency is given an opportunity to prove, by clear and convincing evidence, that it would have taken the same personnel action in the absence of the protected disclosure. 5 U.S.C. § 1221(e)(2); see Fellhoelter v. Department of Agriculture, 568 F.3d 965, 970–71 (Fed. Cir. 2009). The WPA is a “remedial statute,” and its terms are to be construed “broadly.” Weed v. Soc. Sec. Admin., 113 M.S.P.R. 221, 227 (2010). See also Fishbein v. Dep’t of Health & Human Servs., 102 M.S.P.R. 4, 8 (2006) (“Because the WPA is remedial legislation, the Board will construe its provisions liberally to embrace all cases fairly within its scope, so as to effectuate the purpose of the Act.”).

A. Protected Disclosures

An employee engages in a protected disclosure when he or she makes a formal or informal communication of information that he or she reasonably believes evidences “any violation of any law, rule, or regulation” or “gross mismanagement, a gross waste of funds, an abuse of authority, or a substantial and specific danger to public health and safety.” 5 U.S.C. § 2302(b)(8)(A). The WPA also protects disclosures that an employee reasonably believes are evidence of censorship related to research, analysis, or technical information that the employee believes is, or will cause, either a “violation of law, rule or regulation” or “gross mismanagement, a gross waste of funds, an abuse of authority, or a substantial and specific danger to public health or safety.” Pub. L. No. 112-199, sec. 110, 126 Stat. 1465 (Nov. 27, 2012). Protected disclosures include those made to a supervisor or to a person who participated in the activity that was the subject of the disclosure, as well as those made “during the normal course of duties of an employee.” Id.; Day v. Dep’t of Homeland Sec., 119 M.S.P.R. 589, 599 (2013).

The WPA defines a “disclosure” very broadly. See 5 U.S.C. § 2302(a)(2)(D) (“‘disclosure’ means a formal or informal communication or transmission”). The relevant inquiry is whether an employee “reasonably believed” that the disclosure evinces a violation of any law, rule, or regulation; gross mismanagement; gross waste of funds; abuse of authority, or; a substantial and specific danger to public health or safety. See, e.g., Miller v. Dep’t of Homeland Sec., 2009 WL 1445346 (M.S.P.B. May 4, 2009) (employee’s criticisms of new policies were protected disclosures under WPA because he reasonably believed that these policy changes would pose a substantial and specific danger to public safety).

B. Personnel Action

Under the Whistleblower Protection Act, a “personnel action” may refer to:

  1. an appointment;

  2. a promotion;
  3. an action under chapter 75 of this title or other disciplinary or corrective action;
  4. a detail, transfer, or reassignment;
  5. a reinstatement;
  6. a restoration;
  7. a reemployment;
  8. a performance evaluation under chapter 43 of this title or under title 38;
  9. a decision concerning pay, benefits, or awards, or concerning education or training if the education or training may reasonably be expected to lead to an appointment, promotion, performance evaluation, or other action described in this subparagraph;
  10. a decision to order psychiatric testing or examination;
  11. the implementation or enforcement of any nondisclosure policy, form, or agreement; and
  12. any other significant change in duties, responsibilities, or working conditions;
  13. 5 USCA § 2302(a)(2)(A). The list is comprehensive, and covers a wide swath of adverse personnel actions.

C. Contributing Factor

Under the “knowledge/timing test,” an individual may demonstrate that a protected disclosure was a contributing factor to a personnel action through circumstantial evidence, such as evidence that the official taking the personnel action knew of the whistleblowing disclosure and took the personnel action within a period of time such that a reasonable person could conclude that the disclosure was a contributing factor in the personnel action. See Atkinson v. Dep’t of State, 107 M.S.P.R. 136, 141 (2007) (citing 5 U.S.C. § 1221(e)(1)).

However, whistleblowing activities may still be a contributing factor in the taking or failure to take a personnel action, even absent evidence that the deciding official had knowledge of the whistleblowing activities. See Dorney v. Dep’t of Army, 117 M.S.P.R. 480, 485–86 (2012). If the deciding official was influenced by one with knowledge of the whistleblowing activities, then such activities may be a contributing factor to personnel actions under the WPA. Id.

Sistek v. Dep’t of Veterans Affairs

A. Facts and Procedural History

Between 2012 and 2014, Leonard Sistek, Jr., then-director at the Department of Veterans Affairs (“VA”), disclosed information to agency staff, one of his supervisors, and the VA’s Office of the Inspector General (“OIG”) about inappropriate financial practice within the VA. Shortly thereafter, his supervisor appointed an Administrative Investigation Board (“AIB”) to investigate unrelated misconduct within the organization. His supervisor formally added Mr. Sistek as a subject of the investigation.

The AIB investigation found that the management team, which included Mr. Sistek, failed to report allegations about an inappropriate sexual relationship between two other staff members, and it recommended that Mr. Sistek receive “an admonishment or reprimand.” Consistent with the recommendation, Mr. Sistek’s supervisor issued a letter of reprimand in August 2014. In January 2015, without explanation, Mr. Sistek’s second-level supervisor rescinded the letter of reprimand and expunged it from Mr. Sistek’s record. In March 2015, the OIG confirmed that the concerns previously raised by Mr. Sistek were justified, and that the VA had violated appropriations law and used funds in unauthorized ways.

Mr. Sistek filed a complaint with the U.S. Office of Special Counsel (“OSC”), alleging whistleblower reprisal. After OSC issued a closure letter, Mr. Sistek filed an individual right of action appeal.

The Administrative Judge (“AJ”), considered whether the investigation and resulting letter of reprimand constituted prohibited personnel actions. The AJ determined that a retaliatory investigation is not a personnel action under the WPA and declined to order corrective action in favor of Mr. Sistek. See Sistek v. Dep’t of Veterans Affairs, 2018 MSPB LEXIS 3010 (M.S.P.B. Aug. 8, 2018). The AJ’s initial decision became the final decision of the MSPB, and Mr. Sistek petitioned the Federal Circuit for review.

B. The Federal Circuit’s Finding of Harmless Error

The Federal Circuit affirmed the Board’s decision. First, it reasoned that the WPA’s list of eleven specific personnel actions does not mention a “retaliatory investigation,” or indeed, “any investigation at all.” Sistek v. Dep’t of Veterans Affairs, 955 F.3d 948, 954 (Fed. Cir. 2020). Second, the court found that the investigation against Mr. Sistek did not significantly alter his job or working conditions, and thus did not fall within the last catchall provision of the WPA’s list of personnel actions. “[I]nvestigations may qualify as personnel actions ‘if they result in a significant change in job duties, responsibilities, or working conditions.’” Sistek, 955 F.3d at 955 (quoting S. Rep. No. 112-155, at 20 (2012)). The court elaborated that in certain circumstances, “an investigation alone could constitute a significant change in working condition,” or “a retaliatory investigation could contribute toward the creation of a hostile work environment that is actionable as a significant change in working conditions.” Id. In such circumstances, a retaliatory investigation would be a qualifying personnel action under the WPA. The Sistek Court held, however, that the investigation did not establish a significant change in working conditions because Mr. Sistek was interviewed once, did not offer evidence of a hostile work environment, and the resulting letter of reprimand was later rescinded and expunged. See id. at 956.

Third, the court considered Mr. Sistek’s effort to bring his claim within the rationale of controlling precedent on retaliatory investigations. See Russell v. Dep’t of Justice, 76 M.S.P.R. 317 (1997). In Russell, a whistleblower disclosed misconduct by two of his superiors, after which, one of the superiors initiated an investigation of the whistleblower’s conduct, resulting in disciplinary charges against the whistleblower and the whistleblower’s demotion. Id. at 321. The Board held that the agency investigation was evidence of prohibited retaliation because the investigation was “so closely related to the personnel action that it could have been a pretext for gathering evidence to retaliate, and the agency [did] not show by clear and convincing evidence that the evidence would have been gathered absent the protected disclosure.” Id. at 324. “That the investigation itself is conducted in a fair and impartial manner, or that certain acts of misconduct are discovered during the investigation, does not relieve an agency of its obligation to demonstrate by clear and convincing evidence that it would have taken the same personnel action in the absence of the protected disclosure.” Id. (citing 5 U.S.C. § 1221(e)(2)). In other words, if an agency investigation leads to an adverse personnel action, that investigation—coupled with the ensuing personnel action—is prohibited retaliation, unless the agency can demonstrate that it would have commenced the same investigation and taken the same personnel action absent the protected disclosure. “To here hold otherwise would sanction the use of a purely retaliatory tool, selective investigations.” Id. at 325.

The Sistek court acknowledged that Russell is “the Board’s foundational decision in this area,” and that the drafters of the Whistleblower Protection Enhancement Act (“WPEA”), Pub. L. No. 112-199, 126 Stat. 1465 (2012), intended that Russell would remain “governing law.” Sistek, 955 F.3d at 955. Applying Russell, the Sistek court found that the Board erred by failing to consider Mr. Sistek’s allegedly retaliatory investigation as part of its evaluation of the letter of reprimand. See id. at 957. Applying Russell, the VA’s investigation into Mr. Sistek was “so closely related” to the letter of reprimand “that it could have been a pretext for gathering evidence to retaliate.” Russell, 76 M.S.P.R. at 324. By “fail[ing] to apply Russell in evaluating the letter of reprimand,” the Board committed error. Sistek, 955 F.3d at 957.

Regardless, the Sistek Court held that the Board’s error was harmless. Id. The Court distinguished the present facts from the facts of Russell “because here there is no evidence that the official who initiated the allegedly retaliatory investigation had knowledge of any protected disclosures.” Id. The Court held that the supervisor who initiated the investigation lacked both actual and constructive knowledge of Mr. Sistek’s protected disclosures, and further, Mr. Sistek did not allege such knowledge. By failing to allege knowledge, Mr. Sistek could not demonstrate that his protected disclosure was a contributing factor to the alleged personnel action. In other words, even if the investigation and letter of reprimand were an adverse action, the WPA claim would have nonetheless failed because Mr. Sistek did not present sufficient evidence that his whistleblowing was a contributing factor in his adverse action.

Significance of Sistek

Sistek reaffirmed the holding of Russell, that a retaliatory investigation may be a prohibited personnel action if it leads to a significant change in job duties, responsibilities or working conditions; if it creates a hostile working environment, or; if it is “closely related” to a personnel action under the WPA. If Mr. Sistek had demonstrated facts to meet the knowledge/timing causation test, then the Court would have remanded the case to the Board to consider whether the investigation and letter together were qualifying personnel actions. And Russell would mandate that the answer is yes.

Further, if an employee can demonstrate that an investigation was undertaken in retaliation for a protected disclosure, the WPA provides that the Board may order corrective action that includes “fees, costs, or damages reasonably incurred due to an agency investigation” that is “commenced, expanded, or extended in retaliation” for a protected disclosure or activity—i.e., a retaliatory investigation. 5 U.S.C. §§ 1214(h), 1221(g)(4).

“So long as a protected disclosure is a contributing factor to the contested personnel action, and the agency cannot prove its affirmative defense, no harm can come to the whistleblower.” Marano v. Dep’t of Justice, 2 F.3d 1137, 1142 (Fed. Cir. 1993). The WPA thus continues to protect federal whistleblowers from retaliatory investigations, and Sistek merely provides a cautionary note about establishing the causation element of such a claim.

© Katz, Marshall & Banks, LLP
For more on whistleblower protections, see the National Law Review Criminal Law & Business Crimes section.